Analysis

Financing the infrastructure sector is a major challenge for Indonesia. The government simply does not have the financial muscle to fund all of the necessary infrastructure projects on its own. According to the Ministry of Public Works, Indonesia requires $192bn of infrastructure investment between 2010 and 2014. The government and state-owned enterprises can only provide around $56bn, so the private sector will need to chip in as well. Indonesia plans to invest more than $390bn in infrastructure until 2025. Almost half of it will need to be financed by the private sector. According to M Hatta Rajasa, the coordinating minister for the economic affairs, there remains a funding gap of 41% that needs to come from the private sector. Of the anticipated 25 priority projects set to begin by 2017, the government wants 16 to take the form of public-private partnerships (PPPs). The National Development Planning Agency has identified 27 projects worth $47.3bn to be made available to investors from 2014. This is a very ambitious target, and the country’s record so far has been less than stellar. Most PPP projects in electrification and water supply are still in development. While some projects are yet to be released, others have started and then stalled. No PPP project has yet achieved financial closure.

Sources Of Finance

A number of state-owned entities have been created to assist with the financing of public and PPP projects. Sarana Multi Infrastruktur and Indonesia Infrastructure Finance (IIF) were set up to provide alternative sources of funding through debt and equity. The former is wholly owned by the Indonesian government, while the latter is partly funded by the Asian Development Bank (ADB), the International Finance Corporation and two private financing institutions, Sumitomo Mitsui Bank Corporation and German Investment and Development Corporation. The Indonesia Infrastructure Guarantee Fund (IIGF) and the IIF were established by the government in 2009 to provide new means of funding infrastructure projects in a move that was broadly welcomed by investors.

IIGF provides financial guarantees for specific projects, while IIF was created to drum up local capital for infrastructure projects. Penjaminan Infrastruktur Indonesia is another government-owned entity that offers project guarantees to the private sector. It also aims to improve the creditworthiness of public sector partners, and thereby encouraging private sector participation in projects. Sovereign wealth fund Pusat Investasi Pemerintah is financing land acquisition for PPPs. The Ministry of Finance has also established a Viability Gap Fund to ensure there is additional capital available for projects.

Raising Capital

The local financial ecosystem is still in its infancy, and foreign fund managers are hesitant about putting money into Indonesia’s infrastructure sector. That is because risk allocation in the sector is still not favourable to investors. The IIGF guarantee, for instance, applies to only a handful of projects. It has yet to agree on the terms for its first guarantee – for Central Java’s coal-fired power project (involving two 1000-MW plants). Investors believe the fund may not be sufficiently capitalised, and therefore have concerns regarding its effectiveness.

High Cost Of Local Borrowing

The spread between lending and deposit rates in Indonesia is high. According to data compiled by Bloomberg in 2013, the average margin for the country’s leading banks is 7% higher than any of the other 20 largest economies in the world. This makes borrowing from local banks expensive. The difficulty of raising local finance has only been exacerbated by the central bank’s decision to hike interbank lending rates by 25 basis points to 7.5% in November 2013 in an attempt to manage the current account deficit, which as of the fourth quarter of 2013 stood at 3.3% of GDP. Although the high cost of local borrowing is less of a constraint for foreign investors, it does put local enterprises involved in the sector at a disadvantage. Indonesia ranked 86th out of a total of 189 countries on ease of getting credit in the World Bank’s 2014 “Doing Business” report. By comparison, its peers in the region – Thailand (ranked 73rd) and Malaysia (ranked first) – did far better.

Relying On International Finance

The domestic banking sector has limited experience of project risk calculation and this makes it difficult for the government to raise local capital for long-term infrastructure investments. Thus, although the cost of accessing the international financial markets is high, Indonesia has had to rely on them.

Infrastructure projects have mostly been funded by foreign banks and multilateral lending agencies, such as the World Bank or the ADB. However, the biggest donor is the Japan International Cooperation Agency (JICA), which is funding a total of 45 fast-track projects in and around the Jakarta metropolitan area. Its $13bn in funding will help cover almost 30% of the project costs, while the rest will come from the Indonesian government and the private sector. Projects include roads, rail, water and sanitation, energy and ports.

With this kind of funding Asian firms often have an advantage over their Western competitors when it comes to bidding for projects in Indonesia. These companies are often protected from risk by their respective governments and bring with them relatively inexpensive and easily obtainable export-credit financing. Japanese, Chinese and South Korean financial institutions provide Indonesia with liberal financing at below-market rates. For example, TheJakarta Globe reported in 2013 that the loan provided to build the Indramayu coal-fired power project carried an annual interest rate of only 0.01%, with a 40-year repayment time frame and a grace period of 10 years thanks to the JICA.

While lending agencies are ready to assist, since the 1997-98 Asian financial crisis Indonesia has been averse to taking on large-scale foreign debt. The use of offshore bonds for infrastructure financing has thus grown substantially. It offers advantages. First, bonds can reduce the risk of speculative capital, which can bring infrastructure projects to a sudden halt in the event of capital flight. Second, it minimises default risk for the investors.

The government’s target for bond issuance in first-quarter 2014 is Rp54trn ($5.4bn), and following a Rp10trn ($1bn) sale in mid-March, it seemed to be largely on track to reach this. With the passing of the land acquisition act, there has been a surge of optimism among investors regarding land acquisition for infrastructure projects. However, a decentralised political structure and challenges to the law do present some concerns. There has been some controversy due to previous legislation that restricts the government’s authority to take over land, as well as uncertainty over legal ownership titles.

Budgetary Disbursement

There are also several key bureaucratic and institutional roadblocks that make obtaining adequate financing for infrastructure projects difficult. Ministries, for instance, have trouble disbursing their budgets. In 2013 the Ministry of Public Works announced plans to open bidding for 22,736 infrastructure contracts worth Rp73.41trn ($7.3bn) in 2013, despite having only disbursed about 77% of its Rp75trn ($7.5bn) 2012 budget as of early December 2012. The Ministry of Finance insists on spending existing budgetary allotments first, and before accepting other sources of finance. According to the World Bank, development agencies have reported that some ministries have turned down desired funding for fear of penalisation by the Ministry of Finance for not spending the budgets allotted to them in full. Some efforts have been made to address such issues. Spending rules have been revised to speed up disbursement. According to Anny Ratnawati, the vice-finance minister, new rules allow ministries to hold tenders in November for projects to be implemented in the following year, and provinces, regencies, and ministries must prepare disbursement of their budgets every month.

Inherent in the PPP model is the expectation that the government would not need to provide the entire project financing package, but investors will put up finance only when they see adequate returns that will make up for the project costs and provide profit. Yet there remains a widespread view in the investor community that most projects proposed under the PPP model in Indonesia lack the financial feasibility they seek. Although subsidies are being phased out, low tariffs in the power and water sector make it unattractive for investors to finance projects that require a long time to break even. Until such issues can be resolved, the government should be willing to put in more on its side to finance the projects.

Despite the challenges and risks, Indonesia’s infrastructure expansion over the next six years looks set to provide increasingly attractive opportunities for international investors and financial institutions.